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Students' Pain, Sallie's Gain

Independence is probably the best thing that ever happened to Sallie Mae. Since Congress began cutting its government apron strings in 1996, allowing the student-loan provider to become a stockholder-owned company, Sallie's stock (symbol SLM) has climbed nearly 750%.

Now officially called SLM Corp. (but still known by its girlhood name), Sallie is the dominant player in the lucrative, federally guaranteed student-loan market. Lenders are effectively promised a minimum spread between the interest rate at which they borrow money and the higher rate they place on loans to others. This spread accounts for 66% of Sallie's revenues, which are expected to hit $3.5 billion this year. What's more, Uncle Sam promises to repay virtually all losses that lenders such as Sallie incur on bad loans.

Political anxieties

So why was the stock off 11% in 2006 through mid October? Because what the government gives, it can take away, and Congress has been wrestling with legislation to renew provisions of the student-loan program. Sallie's business has come through the process intact so far. But investors worry that a Democratic takeover of Congress could tilt the playing field in favor of a rival program in which the government dispenses loan money directly to college financial-aid offices, cutting out middlemen such as SLM. Sallie's chief executive, Tim Fitzpatrick, says that no matter who controls Congress, "we will work both sides of the aisle.Ó

Congress created Sallie Mae in 1972 to buy student loans from private lenders, freeing them to make additional loans. Now cut loose from its governmental ties, Sallie can make its own loans (a more profitable business) as well as purchase them from others. Sallie originates 27% of federally backed student loans, the biggest market share of any entity.

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Sallie is also free to pursue other types of business. For instance, revenues from its debt-collection unit soared 55% in 2005. Earlier this year, Sallie acquired Upromise, a firm that administers 529 college-savings programs in eight states. "That purchase allows us to meet our customers many years before they reach any campus gate,Ó says Fitzpatrick.

Big spreads

The most important factor in Sallie's growth, though, has been the steady escalation of college costs even as caps on guaranteed student loans have essentially remained flat since 1992. As a result, Sallie's portfolio of private, nonguaranteed student loans has surged nearly 40% a year. Those loans expose Sallie to some default risk, but the danger is small. About half of its private loans are co-signed by a parent or another responsible party. Losses amounted to less than 2% of private loans in the first half of this year.

For a financial stock, Sallie seems pricey. At $48, it sells for 17 times 2006 earnings estimates and 14 times 2007 forecasts. But Sallie looks like a good investment at today's price when you consider expected long-term earnings growth of 15% a year, a steadily growing dividend (the stock yields 2.1%) and Sallie's ability to boost profits even in a sagging economy.